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Section 55 of The Indian Partnership Act, 1932 :
Sale of Goodwill after dissolution.- (1) In
settling the accounts of a firm after dissolution , the goodwill shall, subject
to contract between the partners, be included in the assets , and it may be sold
either separately or along with other property of the firm.
Rights of buyer and seller of goodwill.- (2)
Where the goodwill of a firm is sold after dissolution , a partner may carry on
business competing with that of the buyer and he may advertise such business,
but, subject to agreement between him and the buyer., he may not,-
(a) use the firm name,
(b) present himself as carrying on the business of the firm, or
(c) solicit the custom of persons who were dealing with the firm before its
dissolution.
Agreements in restraint of trade-(3) Any partner may, upon the sale of the
goodwill of a firm , make an agreement with the buyer that such partner will not
carry on any business similar to that of the firm within a specified local
limits and notwithstanding anything contained in Section 27 of the Indian
Contract Act , 1872 ,such agreement shall be valid if the restrictions imposed
are reasonable.
Introduction
Dissolution of a firm implies dissolution of the partnership between all
partners of a firm. It may be by agreement, compulsory, due to contingency, by
will and by the court. The settlement of accounts at this point of time is
mentioned in Section 48 and basically provides for payment of debts and payments
to partners. Now, the special provision for Goodwill is Section 55 which deals
with the mode of dealing with goodwill at the time of dissolution. A close
connection of this section exists with Section 53 and Section 54 both of which
speak of restraint of trade. In this article, I have attempted to study Section
55 and have discussed its essentials and select relevant case law.
What is Goodwill?
The first issue towards approaching this section is the definition of goodwill.
'The goodwill which has been the subject of sale is
nothing more than the probability that the old customer will resort to the old
place.' The definition cited above is of course the very
simplistic and rather lay men meaning of what goodwill results in.
It has been more elaborately defined in Trego v. Hunt by
Lord Macnaughten as:
' often it happens that goodwill is the very sap and
life of the business , without which the business would yield little or no
profits . It is the whole advantage whatever it may be , of the reputation and
connection of the firm , which may have been built up by years of honest work or
gained by lavish expenditure of money.'
Goodwill is essentially an intangible asset of a firm accruing to it by the good
conduct and business performance. Therefore it can
effectively be defined as the benefits arising from connection and reputation of
the business and is primarily an asset. It is intangible and rather
difficult to identify per se. Its is also difficult to specify when the goodwill
takes existence and no business which commences possesses goodwill from the
start. It is generated as the business is carried on and may be augmented with
the passage of time.
It has been held in the case of CIT v. B.C. Srinivasa
Setty that the goodwill is affected by everything relating to the
business , the personality of the owners, the nature and character of the
business , its name and reputation , its location , its impact on the
contemporary market and on the prevailing socio-economic ecology.
Lord Eldon's observation in the case of Churton v. Douglas
is a very important aspect of the meaning of goodwill, 'goodwill must mean every
advantage -every positive advantage , If I may so express it as contrasted with
negative advantage of the later partner not carrying on the business himself -
that has been acquired by the old firm in carrying on its business , whether
connected with the premises in which the business was previously carried on, or
with the late firm , or with any other matter carrying with it the benefit of
business.'
It is the public approbation which has been won by the business , and that is
considered as a marketable thing ; it is the probability of the customers or
clientele of the firm resorting to the person or persons who succeed to the
business as a going concern. 'Approbation ' was one of the original meaning of
goodwill before it was used as commercial slang.
Now, at the time of dissolution, the goodwill may be sold separately or along
with the other assets. If there is dissolution of a partnership with a condition
that the assets fall to a particular partner and no mention of goodwill is made,
it is assumed that the goodwill also falls to the partner getting the other
assets. It is therefore quite clear that goodwill is an integral part of the
assets. At this time goodwill might infact be the most important and valuable
asset. Also if there is no express or implied agreement to the effect then the
goodwill may be sold as an asset on insistence of a partner. It must be noted
that earlier neither the Contract Act nor the Partnership Act had any specific
provision on goodwill and it has been only a recent development to include the
section on goodwill as part of partnership act. The question whether the firm
has goodwill or not is a question of fact.
The name of a firm which is included in the goodwill may be excluded from the
sale where use of that name is likely , to expose continuing partners , who
carry on business , to liability. Goodwill of the business sold -- seller of
goodwill may set up rival business but if he tries to attract customs of old
firms he can be restrained by an injunction from doing so, where a person is
taken on the condition that the goodwill shall bring to other partner on
termination of the partnership above principles applies. Also if there exists a
deed of modification to separate business , it cannot be considered a deed of
dissolution and thus will not attract Section 55 of the Indian Partnership Act.
In Laxmidas v. Nanabhai , the question was
regarding maintainability of a suit and counter claims.
The essential reading regarding Section 55 was laid down as '
Goodwill is a part of the assets of a firm. The prima facie rule is that the
goodwill of the firm being a part of that assets has to be sold just like other
assets before the account between the partners can be settled and partnership
wound up.' But no particular reference to goodwill which is only one of
the several assets of a firm in a plaint for taking accounts of a dissolved
partnership is required. Similarly the existence of goodwill is an asset of the
firm , which has to be sold and the proceeds divided between the partners in the
account taking is no bar to the conversion of a counter claim into a plaint in a
cross suit is not easy to comprehend.
What is therefore seen is that goodwill like any other asset can be sold at the
time of dissolution.
The most relevant judgement on this section has been the case of
Khushal Khemgar Shah & others v. m/s Khorshed Banu Dadibar.
The facts of the case read as follows, Dadiba Boatwalla was one of the eight
partners of m/s Meghji Thoban & co. Boatwalla died and by virtue of clause 8 of
the deed of partnership , the business of the firm was continued by surviving
partners.
Now , his widow and son obtained the letter of administration and commenced an
action in the High Court.
This was resisted by the surviving partners and the High Court held that the
plaintiff (widow and son) were not entitled to an account of profits and losses
after the death of Boatwalla. However the court held that the plaintiff was
entitled to 6% interest per annum on Boatwalla's share including the goodwill.
In return the defendants appealed again, contending that the plaintiffs as a
legal representatives were not entitled to a share in the goodwill. The reason
being that the goodwill may be taken into account only when there is dissolution
of the firm and in any event because Boatwalla had already agreed the interest
on goodwill would cease on his death and the business would be continued by the
surviving partners. The Supreme Court through Justice Shah, opined that"
'Section 55 does not allow the interpretation, that, goodwill may be taken
into account only when there is a general dissolution of the firm, and not when
the representatives of the partner claim their share in the firm , which by
express stipulate is to continue notwithstanding death of a partner. The
provision deals with the concept and consequences of dissolution of the firm.
The Act does not operate to extinguish the right in the assets of the firm of a
partner who dies , when the partnership agreement provides that on his death,
the partnership continues.'
The court also laid down the guidelines of interpretation of the deed of
partnership.
'The court must insist upon some indication that the right to a share in the
assets is by virtue of an agreement; that the surviving partners are entitled to
carry on business on the death of the partner to be extinguished. In the absence
of a provision expressly made or clearly implied , the normal rule that the
share of a partner in the assets devolves upon his legal representatives will
apply to the goodwill as to other assets.'
In Dulaldas Mullick & others v. Ganesh Das Damani
and others , the plaintiff was carrying on business as a paint and varnish
dealer in a shop room, paying rent under the name of D Mullick & Co. He was
indebted to one Gopal Lal Daga , who instituted a suit and got a decree in his
favour. Execution proceedings started and the stock in trade, goodwill and
furniture was sold to one Damani who took possession of the room . The basic
point was whether goodwill includes right of a plaintiff as a tenant.' there can
be no hard and fast rule ; no simple formula and no inflexible and rigid
definitions of the term goodwill, but in each case it is necessary to see the
entire nexus of facts connected with the business whose goodwill is to be
determined. The bench cited Commr. Of Inland Revenue v.
Muller & Co. Margarine Ltd. with respect to the meaning of the word
goodwill. Lord Lindley said ' I understand the word to
include whatever adds value to a business by reason of situation , name and
reputation, connection .goodwill is inseparable from the business to which it
adds value and in my opinion exists where the business is carried on'.
Finally the bench reached the conclusion that tenancy rights were included in
goodwill. Therefore the position which emerges is goodwill is essentially a form
of an asset and is treated in the same way as an ordinary asset.
Rights and Duties of Partners: at the time of sale of
goodwill
At the time of dissolution all partners have the right to sell the goodwill of
the firm for the common benefit of the partners. This does not restrict the
right merely to general dissolution. The legal
representatives of the deceased partner are also entitled to a share in the
goodwill of the partnership which is continued after the death of the partner.
Goodwill is essentially an estimation by the customers and
protecting goodwill means protecting the custom of the firm. The
seller may continue to trade in the same field, can
offer competition in every lawful manner, advertise to the general public and
follow other commercial tactics. He may offer better and cheaper services , if
he can so afford , and divert the flow of customers to his new place , but not,
by a personalized approach or solicitation. This is necessary to ensure freedom
of trade to every individual.
However if the seller of the goodwill represents to the customer that he is the
same person carrying on the old business, it would destroy the buyer's purchase
of goodwill. Therefore certain restrictions are required to be imposed on the
seller and buyer of goodwill. This section essentially speaks of such
restrictions and the boundary within which both parties have to function. Though
restrictions are to be imposed, it must also be noted that common law normally
does not provide for restrictions on trade . Therefore a
level of balance has to be maintained.
Sub section 2 of Section 55 provides that though
the seller may continue the business as he pleases, he may however not ,
# Use the firm name,
#Cannot represent to the people that he is carrying
on the old business.
# He cannot solicit the custom of persons who were
dealing with the firm before its dissolution.
# He cannot approach customers with the intention
of diverting them to his business, but 'is at liberty to
deal with them if they come to him of their own accord'.
Even the representatives of a deceased partner cannot do such solicitation.
An appropriate example at this stage can be the case of
Churton v. Doughlas where a partnership business was being carried on by
three persons. One of them J.D retired and the other partners continued the
business under the name of 'Late J.D. & Co.' ,instead of the previous name 'J.D.
& Co.'. They also resumed business in premises adjoining the old premise and
distributed a circular to the customers to this effect. Towards such action, the
court decided that. 'though the remaining partners had a
right to establish a rival business, but they had no right to use the same name
or to solicit the customers of the old firm.'
The case also held that the restriction laid down in this 'section
applies not only to the use of the firm name but also use of any other name, so
similar to the firm name as to lead the public to believe that they are dealing
with the old firm.'
The person may be allowed to use the firm name if that happens to be his own
name , though he may be restricted from using his name dishonestly. He can be
restrained if it is established that the similarity of the to be assigned trade
name is such as its use would be, under the particular circumstances a
derogation from the grant.
Subsection 3 deals with agreement in restraint of trade and lays down
that any partner may, upon sale of goodwill of a firm, make an agreement with
the buyer that such partner will not carry on any business similar to that of
the firm within a specified period or within a specified local limit, and not
withstanding anything contained in Section 27 of the Indian Contract Act 1872.,
such agreement shall be valid if the restrictions imposed are reasonable.
Therefore the essential components of the section are
as follows:
The seller may make an agreement with the buyer of not carrying on business :
# Similar to the firms
# Within a specified period
# Within the specified local limits, if the
restrictions imposed are reasonable.
The parties provide for restrictions in the agreement. In order to maintain the
value of the goodwill it is usual for the buyer to require the seller to enter
into an agreement restricting his right of competition. Sub-section 3
legitimizes this. The object of the agreement is to enable the buyer of goodwill
to have time to establish himself and attach to himself the custom he has bought
and make it his very own. Accordingly the restriction cannot be absolute and
thus the section provides that the
# It should specify the period of local limits of
the restraint.
#The restriction must be reasonable.
The reasonableness of the restriction depends on the nature of the business.
Where a partner of the firm manufacturing and selling bakelite goods, sold the
business to the other partner and agreed not to carry on a similar business for
three years within the city of Bombay , the restriction was held reasonable in
the case of Krishnarao v. Shankar . Also where the
agreement for dissolving a firm of insurance agents, in which an outgoing
partner was restrained from carrying on insurance business anywhere except
Karachi , the restriction was regarded as unreasonable because though 'it
was unlimited and worldwide, permission was within very narrow limits.'
In Hukmi Chand v. Jaipur Ice & Oil Mills Co. most
elaborate observations have been made on this aspect of the issue. There was a
partnership composed of six partners. Two partners left the firm and the
remaining continued the business upto March 31, 1958, the date on which it
dissolved. Firm had a factory and a residential house. On the day of dissolution
one partner Kalicharan retired and was paid his of assets and Rs. 11001 as
goodwill share. At the time of dissolution , it was agreed between Kalicharan
and the others like Kishanlal, Mahadeo Prasad, Satya Narayan that the land
premise and the house could be the exclusive property of Kalicharan with full
rights of sale and mortgage and that Kalicharan could get a boundary wall
constituted or have a wire fencing and open a separate door towards the road
side , but there could be no entry or exit towards the factory compound. It was
also decided that Kalicharan could not carry the same kind of business on the
Land.
Now, Kalicharan sold his share to his father for a consideration, by a
registered sale deed. Later, Kalicharan's father, wife and son (Hukum Chand-major
son, Rajgopal- minor son) entered into a partnership to carry on the business on
the land. The company filed a suit through Mahadeo Prasad and asked for a
permanent injunction.
The Trial Court adjudged in favour of the Company.
The High Court made a reference to Section 27 , of the Indian Contract Act and
Section 32, 54 and 55 of the Indian Partnership Act.
Some important observations from this landmark case are discussed below:
'The onus to prove that the condition imposed on an
agreement in restraint of trade is reasonable is on the party which pleads that
they are reasonable'.
It was said that there was nothing indefinite about the covenant because it
appears to be reasonable to safeguard the interest of the buyer of the goodwill.
Also it cannot be said that there is no time limit. The moment the purchaser
ceases to carry on such business the inherent time limit ends.
The case of Shaikh Kalu v. Ram Saran Bhagat was
cited stating
' whether the limits prescribed in the contract are reasonable or not depends
upon the kind of business to protect which the contract is made and the
reasonableness of the restraint imposed must be ascertained by reference to
nature of business and situation of parties.'
A restraint can only be reasonable when:
# Its in the interest of the restraining parties
# Its in the interest of public.
In the same case Lord Macnaughten said that:
'it is not right to profess and to purport to sell that
which you do not mean the purchaser to have , it is not an honest thing to
pocket the price and then to recapture the subject of sale , to decoy it away or
call it back before the purchaser had had time to attract it to himself and make
it his very own.'
The bench also relied on the Restatement of the Law of Contract of the American
Law Institute (1932 Edn. Vol II), while mentioning the situations under which
trade may be considered unreasonable:
The observation was that a restraint on trade is unreasonable if it :
# Is greater than required for the protection of
person for whose benefit the restraint is imposed.
# Imposes undue hardships.
# Tends to create a monopoly or controls prices
artificially or unreasonably results in the alienation or use of anything.
# Is based on a promise to refrain or is not
ancillary to any issue.
The case dealt at length with the issue of restraint on trade and the
contractual principles attached. They applied the rule from
Tulk v. Moxhay in reaching the conclusion that the,
'benefit of a negative restricted covenant with regard to
the contracts concerning land may be assigned and so third parties may acquire
such rights under a contract to which they are not privy. If a person acquires
interest in the land from another , either by purchase , lease etc, or at the
time of dissolution upon a term which binds him to observe certain covenants,
the assignee will take the rights and obligations and will be bound by it.'
Where restraint affecting the commercial use of and is accepted by one who
enjoyed his interest in the land before making of the arrangement under which
the restraint was imposed it is clearly established that the doctrine of
restraint of trade applies to the same extent as it otherwise would.
The bench finally concluded that while signing the agreement Kalicharan was
aware of the restraint and therefore was expected to act according to it.
Moreover, since the parties involved in the present case happen to be
Kalicharan's closes family members they were also expected to know such details.
Conclusion
Despite availability of very scarce case law on the issue it can still be
concluded, that the position on Section 55 is well settled and that goodwill is
a saleable asset at the time of dissolution and renders certain obligations on
part of both the buyer and the seller. The restraint under this section is
similar to the one under Section 27 of the Indian Contract Act. The situation
tackled by this section, is essentially one that falls within the exceptions of
section 27. The said provision reads: 'One who sells the
goodwill of a business may agree with the buyer to refrain from carrying on a
similar business, within specified local limits, so long as the buyer, or any
person deriving title to the goodwill from him, carries on a like business
therein; provided that such limits appear to the court reasonable, regard being
had to the nature of the business.' A litigation
under this section would essentially involve, determination of goodwill and
thereafter the duties connected and to ensue that they are in 'consonance with
the common understanding of mankind and the rudiments of commercial morality.'
The underlying principle of this section is benefit of the buyer of goodwill
which here is assured by a relative restraint on trade by the seller.
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The author can be reached at :
vanshajashukla@legalserviceindia.com
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